Emerging-market central banks are increasingly tasked with defending local currencies, as they battle against speculative attacks and the repercussions of fiscal shortfalls. In Latin America, recent currency interventions by central banks suggest that their efforts to combat market volatility will persist until governments rein in their spending. Meanwhile, in Asia, the People’s Bank of China (PBOC) is utilizing more tools to stabilize the yuan, which has been weakened by sluggish growth, disappointing fiscal stimulus, and threats from U.S. tariffs.
Brendan McKenna, an emerging-markets economist and foreign-exchange strategist at Wells Fargo Securities, emphasized that central bank interventions alone cannot sustainably defend regional currencies. He argues that fiscal responsibility is key to stabilizing currencies in the long term.
The dollar’s rise, driven by a robust U.S. economy and expectations of fewer interest-rate cuts from the Federal Reserve, has put central banks worldwide on alert. Their primary concern is preventing capital outflows and defending their currencies. However, many emerging-market governments are constrained by high debt levels from the COVID-19 pandemic, which limits their ability to deploy further fiscal measures to stimulate growth.
PBOC’s Struggle to Stabilize the Yuan
The PBOC is taking an active approach to defend the yuan, maintaining a tight grip on its daily reference rate and limiting fluctuations to a 2% range against the dollar. Additionally, the bank plans to sell bills in Hong Kong to tighten offshore liquidity and increase demand for the yuan. However, these measures have not fully stemmed bearish market bets, as the onshore yuan continues to hover near the lower end of its allowable trading range.
As the economic powerhouse of emerging Asia, China’s battle against currency speculators is closely monitored. The PBOC recently suspended government bond purchases to curb declining bond yields and the yuan. Despite this, markets remain on edge, especially as traders await the policies of U.S. President-elect Donald Trump, who is expected to unveil trade policies that could have a significant impact on the yuan.
“We anticipate that Beijing will respond to major tariff announcements from Trump’s team with a one-off devaluation of the yuan,” said Homin Lee, senior macro strategist at Lombard Odier. This flexibility could provide China with more room for monetary easing to support the economy. In its most recent statement, the PBOC reaffirmed its commitment to lower interest rates and reduce the reserve requirement ratio for banks “at an appropriate time.” China’s finance minister also emphasized the country’s proactive fiscal policy and its efforts to accelerate pro-growth measures.
Analysts at Bank of America predict that the yuan could weaken further, reaching 7.6 per dollar in the first half of the year.
Fiscal Pressures and Monetary Policy Limitations
The growing risk of fiscal dominance, where ballooning budget deficits fuel inflation, is undermining the effectiveness of monetary policy in emerging markets. In Brazil, economists have revised their inflation forecasts for 2025, projecting it will exceed the central bank’s target range. Despite this, many analysts expect the Banco Central do Brasil to continue its tightening cycle through mid-2025. However, growing investor skepticism regarding President Luiz Inácio Lula da Silva’s ability to address Brazil’s escalating budget deficit has triggered a dramatic decline in the real. In response, Brazil’s central bank spent approximately $20 billion in reserves over two weeks to defend the currency, though market stability was largely driven by a weakening U.S. dollar rather than domestic policy actions.
Wells Fargo’s McKenna suggests that fiscal concerns in Brazil will persist, especially in light of upcoming elections in 2026. Similar fiscal risks are emerging in Mexico and Colombia, where rising budget deficits could exacerbate inflationary pressures, even as inflation remains relatively contained.
Lessons from Past Crises
Emerging-market policymakers have become more adept at handling fiscal crises, learning from the Latin American debt crisis of the 1980s and the Asian financial crisis of the late 1990s. In response to rising inflation, Latin American central banks began raising interest rates in 2021, acting ahead of many developed-market counterparts. However, escalating price pressures are now hindering further rate cuts at a time when governments’ pandemic-related spending continues to strain fiscal balances.
For example, Thailand’s debt-to-GDP ratio surged to 55% in 2023, up from 34% in 2019, according to the International Monetary Fund. Similar trends are observed in China, Chile, Colombia, and Poland. The growing concern over fiscal dominance is becoming a central topic for emerging-market investors, according to a December note by Citigroup strategists Luis E. Costa and Rohit Garg. Central banks in countries such as Hungary, Poland, Brazil, and Mexico have recently cited fiscal risks as a reason for caution in their monetary policies.
As emerging-market economies continue to grapple with these fiscal and currency challenges, it remains clear that restoring fiscal discipline will be crucial for long-term currency stability.
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